The Song Remains the Same: Few 2021 COLA Adjustments for Retirement Plans

On October 26, 2020, the IRS announced 2021 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.  The maximum annual limit on salary deferral contributions to 401(k), 403(b), and 457 plans remained the same for 2021 as it was in 2020, at $19,500, and the catch-up contribution limit for employees age 50 and older also stayed the same at $6,500.  The SIMPLE employee contribution limit of $13,500 was also unchanged, as were the annual deductible IRA contribution and age 50 catch-up limits ($6,000 and $1,000, respectively).  The Section 415(c) dollar limit for annual additions to a retirement account was increased to $58,000 from $57,000 and the maximum limit on annual compensation under Section 401(a)(17) increased from $285,000 to $290,000.  Below we list the changed and unchanged dollar limits for 2021. Citations below are to the Internal Revenue Code. (Click on the chart for a larger image.)

In a separate announcement, the Social Security Taxable Wage Base for 2021 increased to $142,800 from the prior limit of 137,700 in 2020.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. (c) 2020 Christine P. Roberts, all rights reserved.

Photo Credit: Jude Beck, Unsplash

California Employers: Get Ready for the CalSavers Program

Beginning on July 1, 2019, California private employers with 5 or more employees, who do not already sponsor a retirement plan, may enroll in the CalSavers Retirement Savings Program (CalSavers).   Mandated employers must enroll in CalSavers according to the following schedule:

  • Over 100 employees – June 30, 2020
  • 50-99 employees – June 30, 2021
  • 5-49 more employees – June 30, 2022

Below, we describe the key features of the CalSavers program.

  • CalSavers is the byproduct of California Senate Bill 1234, which Governor Brown signed into law in 2016. It is codified in Title 21 of the Government Code and in applicable regulations. It creates a state board tasked with developing a workplace retirement savings program for employers with at least 5 employees that do not sponsor their own retirement plans (“Eligible Employers”). This may mean a 401(k) plan, a 403(b) plan, a SEP or SIMPLE plan, or a multiple employer (union) plan.
  • CalSavers applies to private for-profit and non-profit employers, but not to federal or state governmental entities.
  • CalSavers calls for employees aged at least 18, and receiving a Form W-2 from an eligible employer, to be automatically enrolled in the CalSavers program after a 30 day period, during which they may either opt out, or customize their contribution level and investment choices.
  • The default is an employee contribution of 5% of their wages subject to income tax withholding, automatically increasing each year by 1% to a maximum contribution level of 8%. Employer contributions currently are prohibited, but may be allowed at a later date.
  • Prior to their mandatory participation date, Eligible Employers will receive a notice from the CalSavers program containing an access code, and a written notice that may be forwarded to employees. Eligible Employers must log on to the CalSavers site to either register online, or certify their exemption from Calsavers by stating that their business already maintains a retirement plan. The link to do so is here. To do either, you will need your federal tax ID number and your California payroll tax number, as well as the access code provided in the CalSavers Notice.
  • Eligible Employers who enroll in CalSavers will provide some basic employee roster information to CalSavers. CalSavers will then contact employees directly to notify them of the program and to instruct them about how to enroll or opt-out online. Those who enroll will have an online account which they can access in order to change their contribution levels or investment selections.
  • Once an Eligible Employer has enrolled in CalSavers, their subsequent obligations are limited to deducting and remitting each enrolled employee’s contributions each pay period, and to adding new eligible employees within 30 days of hire (or of attaining eligibility by turning age 18, if later).
  • Eligible employers may delegate their third party payroll provider to fulfill these functions, if the payroll provider agrees and is equipped to do so.
  • Eligible Employers are shielded from fiduciary liability to employees that might otherwise arise regarding investment performance or other aspects of participation in the CalSavers program.
  • There are employer penalties for noncompliance. The penalty is $250 per eligible employee for failure to comply after 90 days of receiving the CalSavers notification, and $500 per eligible employee if noncompliance extends to 180 days or more after the notice.
  • Eligible Employers must remain neutral about the CalSavers program and may not encourage employees to participate, or discourage them from doing so. They should refer employees with questions about CalSavers to the CalSavers website or to Client Services at 855-650-6918 or clientservices@calsavers.com.

The CalSavers program was challenged in court by a California taxpayer association, on the grounds that it was preempted by ERISA as a consequence of the automatic enrollment feature.[1] On March 29, 2019, a federal court judge concluded that ERISA did not prevent operation of the CalSavers program, because the program only applies to employers who do not have retirement plans governed by ERISA.  The taxpayer association is deciding whether to amend their complaint by May 25, 2019, or appeal the decision to the Ninth Circuit.  Therefore, further litigation may ensue, but after this important early victory the timely rollout of CalSavers seems likely, and employers should act accordingly.  (Programs similar to CalSavers are up and running in Oregon and Illinois, and have been proposed in a handful of other states.)

Employers reviewing this information should pause to re-examine their earlier decisions against maintaining a retirement plan for employees. The benefit of sponsoring your own plan is that it will bear the “brand” of your business and will serve to attract and retain quality employees.  Further, the administrative functions you must fulfill in order to participate in CalSavers are comparable to those required by a SEP or SIMPLE plan, both of which offer larger contribution limits and an employer deduction to boot.  If mandatory participation in CalSavers is bearing down on your business, now is a good time to talk to a retirement plan consultant, or your CPA or attorney, to determine whether you can leverage the time investment CalSavers will require, into a retirement arrangement that offers considerably more to your business and your employees.

In the meantime, here are some online resources for Eligible Employers:

  • Employer checklist – a punchlist to help you prepare for enrollment.
  • CalSavers Program Disclosure Booklet – this goes into significant detail about the way CalSavers contributions will be invested; notably the cost of these investments (consisting of an underlying fund fee, a state fee, and a program administration fee), will range at launch between $0.83 to $0.95 for every $100 invested, which is approximately twice the cost load for typical 401(k) investments.  It is expected that the fees will drop as the assets in the program grow, according to a breakpoint schedule approved by the CalSavers board and program administrator.
  • Online FAQ

[1] A Department of Labor “safe harbor” dating back to 1975 excludes “completely voluntary” programs with limited employer involvement from the definition of an ERISA plan.  29 C.F.R. § 2510.3-2(d).  The Obama administration finalized regulations in 2016 that would have expressly permitted state programs like CalSavers as exempt from ERISA coverage. However, Congress passed legislation in 2017 that repealed those regulations.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader.  Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose.  © 2019 Christine P. Roberts, all rights reserved.

Bankruptcy Case Highlights Importance of Promptly Transferring Retirement Assets in Divorce

When a couple divorce, it is not uncommon for one partner to have accumulated significantly larger retirement accounts (e.g., in 401(k) plans or IRAs) than the other.  In such cases the parties generally divide IRA accounts pursuant to Internal Revenue Code 408(d)(6) and/or enter into a qualified domestic relations order (QDRO) to divide a 401(k) or other qualified retirement plan.

The importance of moving promptly to divide and transfer title to retirement accounts in divorce was highlighted in a Bankruptcy Court case from 2018, In re Lerbakken, 590 B.R. 895 (8th Cir. 2018).  In the case, the husband’s failure to take formal legal custody of half of his ex-wife’s 401(k) account (through obtaining a QDRO), and the entirety of one of her IRAs, resulted in those amounts becoming available to creditors in the husband’s bankruptcy case.

In Lerbakken, the court’s dissolution order/property settlement directed Lerbakken’s attorney to submit a QDRO with respect to the 401(k) account, and presumably contained language relevant to transferring title to the IRA, for which a QDRO is not necessary.  However no steps towards obtaining a QDRO or transferring title of the IRA were taken.  When Lerbakken filed a voluntary Chapter 7 bankruptcy petition, he claimed his share of the 401(k) account, and the IRA, as exempt retirement accounts.  The bankruptcy court disallowed the exemption on the basis of the Supreme Court’s opinion in Clark v. Rameker, 134 S.Ct. 2242 (2014), which held that a non-spousal inherited IRA (in that case, from a mother to a daughter) was not entitled to the same protection from bankruptcy creditors as are retirement funds that are individually set aside by the person claiming bankruptcy protection; e.g. inherited accounts are more in the nature of a financial windfall than an intended source of retirement living expenses.

On appeal, the Bankruptcy panel of the 8th Circuit court agreed, noting that Clark v. Rameker limits the bankruptcy exemption to “individuals who create and contribute funds into the retirement account,” and disregarding Lerbakken’s claim that he would use the funds for retirement income.  The court’s final summing up suggests that a different result would have obtained,  had Lerbakken obtained a QDRO and moved the IRA funds into his own name, rather than simply having relied on the wording of the property settlement:

            “We recognize that Lerbakken’s interest in the 401(k) and IRA did not arise in the identical manner as the IRA account addressed in Clark.  This distinction is not material to our de novo review.  Any interest he holds in the Accounts resulted from nothing more than a property settlement.  Applying the reasoning of Clark the 401(k) and IRA accounts are not retirement funds which qualify as exempt under federal law.”  (Emphasis added.)

In essence, the result is that without having taken actual ownership to the retirement funds, Lerbakken could not “borrow” the exemption status for the 401(k) and IRA that his wife would have been able to claim, had she been the bankruptcy debtor.  The fact that Lerbakken himself may have been saving money during the marriage to allow for his ex-wife’s 401(k) and IRA contributions simply does not come into play.   The Lerbakken opinion did not address the question of how one of Lerbakken’s creditors (who included his family law counsel) would actually obtain the assets still held in the ex wife’s 401(k) account and IRA, but presumably they would intervene in any attempt to later transfer these amounts over to Lerbakken or to accounts established on his behalf.

As legal precedent, the Lerbakken ruling is limited to states in the 8th Circuit, namely Arkansas, Iowa, Minnesota, Missouri, Nebraska, and North and South Dakota, but it’s invocation of the Supreme Court’s Clark v. Rameker decision could be invoked in other districts.  It is also possible that this concept could influence state courts deciding the rights of non-bankruptcy creditors.  It therefore provides a timely reminder of the importance of moving promptly to obtain a QDRO and to move IRA assets pursuant to Internal Revenue Code 408(d)(6) pursuant to divorce.  Sitting on your rights in such instances could result in loss of the protected status of retirement savings in a bankruptcy or possibly other creditor situation.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader.  Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose.  © 2019 Christine P. Roberts, all rights reserved.

Beyond the 403(b) Plan: Top 5 Things to Know About Deferred Compensation for Non-Profit Executives

Tax-exempt employers may offer deferred compensation plans to their select executives to allow for retirement savings over and above the dollar limits applicable under a Section 403(b) plan. However the rules governing these arrangements, which fall under Section 457 of the Internal Revenue Code (Code), are complex and often misunderstood.  Below are five things top things to keep in mind in this area, to get the most that the law offers without unpleasant tax surprises along the way.

1.  It’s complicated……

First, there are two types of 457 plans: 457(b) plans and 457(f) plans.  A tax-exempt employer can use both for the same executives but careful planning is advised.  The (b) plans allow set-aside (in the form of employee deferrals or employer contributions) of only $18,000 (in 2017) per year, with no age 50+ catch-up allowance.  Amounts set aside under a (b) plan are not taxed until they are distributed to the executive, an event which must be delayed until termination of employment/retirement, or on the occurrence of unforeseeable circumstances (narrowly defined).  Taxation is delayed until distribution even though the amounts are generally “vested” (no longer subject to forfeiture) when they are contributed.  By contrast there is no dollar limit on the amount that may be set aside under a 457(f) plan (subject to item no. 4, below), but the amounts are taxable upon completion of a vesting schedule (e.g., from 3 to 10 years).  Therefore distribution in full almost always happens upon completion of vesting.  Put most simply, (b) plans are a good way to double an executive’s 403(b) deferral budget, and (f) plans are a good way to help an executive catch up on retirement savings when a retirement or other departure date is within a 3 to 10 year time horizon. Further, in order for an exemption from ERISA to apply, participation in these plans must be limited to a “select group of management or highly compensated employees,” comprising no more than 5% – 10% of the total workforce, referred to as the “top-hat” group.  In a small tax-exempt employer with 10 or 20 employees this may mean only 1 or 2 executives may participate.

2.  You (usually) can’t roll to an IRA.

Generally when an executive is ready to take distribution of benefits from a 457(b) or (f) plan a taxable cash distribution is required, and rollover to an IRA is not an option. (One exception is when the executive moves to a new employer that maintains a 457(b) plan that accepts rollover contributions).  Under a (b) plan, which may allow installment distributions over a period of years, the lack of an IRA rollover option is not so severe, but in a 457(f) plan setting, which generally calls for lump-sum distributions, the tax impact can be severe and the executives should be advised to do advance tax planning with their own CPAs or other tax advisors, well ahead of their planned retirement date or other vesting trigger.  In my experience, lack of the IRA rollover option often comes as an unwelcome surprise to the covered executives.

3.  The assets belong to the organization.

Section 457 plans are non-qualified meaning in relevant part that they assets the plans hold belong to the tax-exempt organization that sponsors the plan until the date(s) they are paid out to the participants. The assets must be held in an account in the name of the organization “FBO” the 457 plan account for the name of the executive.  There is no form of creditor protection but it is possible to put in place a “rabbi trust,” so called because the trust format was first approved by the IRS on behalf of a synagogue for its spiritual leader.  The rabbi trust will not protect the 457 assets from the organization’s creditors, but it will prevent the organization from reneging on the deferred compensation promise to an executive.  This is particularly helpful for an organization that anticipates changes in its board structure after approval of a 457 arrangement.

4.  The normal “reasonable compensation” rules still apply.

Tax-exempt organizations must pay only reasonable compensation, in light of the services provided, to employees and other individuals who comprise “disqualified persons,” a category that includes executive directors and other “C-suite” members. Under the “intermediate sanction” regime the IRS imposes excise taxes on individuals who benefit under, and organization managers (e.g., board members) who approve, compensation arrangements that fail the reasonableness standard.  Deferred compensation arrangements must be reasonable in light of all other compensation and benefits provided to the executives in question and in most cases this will require a third-party compensation consultant’s evaluation and review.  This is a vitally important and often-overlooked piece of deferred compensation compliance in the tax-exempt arena.

5.  DOL notification is required.

As part of the ERISA exemption for top-hat deferred compensation plans, a tax-exempt organization must provide a “top-hat notification letter” to the Department of Labor within 120 days of implementing such a plan. Top-hat letters must be filed electronically.  Failure to timely file a top-hat letter could mean that your deferred compensation plan is liable for ERISA penalties for failure to file annual information returns (Form 5500), to hold plan assets in trust, to make certain disclosures to participants, and on a host of other compliance points.  The Department of Labor permits late filing of top-hat notification letters for payment of a modest fee.  If your organization has a deferred compensation plan in place you should have ready access to a copy of the top-hat notification letter (or confirmation of its online filing) and should consider the DOL correction program if you cannot do so.

Having practiced law in Santa Barbara, California, a haven for charitable organizations, for over 20 years I have had the privilege of working with these special deferred compensation plan rules in many different factual settings and would be happy to help your organization navigate them in order to best retain and reward your valued executives.

The Emerging Benefit Trend of Student Loan Assistance

Employers are by now familiar with the scary statistics on mounting student loan indebtedness, including that approximately 71% of 2015 college seniors graduated with a student loan, and almost 80% of millennials believe that student loan debt will make it harder for them to meet their financial goals.  Per Mark Kantrowitz of Cappex.com, the average student loan balance increased by almost 50% between 2005 and 2015, and now hovers around $35,000 per graduate.

Large student loan debt impacts current employees and prospective new hires in many ways: it may cause rejection of a desired position or promotion due to income needs, it may postpone retirement plan participation due to cash flow needs, and it may delay or even rule out home ownership or starting families, leading to a less stable and community-involved workforce.

Employers want to be able to help mitigate some of the downside of high student loan debt among their employees, but their efforts are hindered by the fact that employer loan payments on behalf of an employee are currently taxable to the employee.

Several pieces of new legislation proposed for the 2017-2018 Congressional term encourage or facilitate employer assistance with student loan repayments through tax incentives. A survey of some of these measures follows:

The Higher Education Loan Payments (HELP) for Students and Parents Act (H.R. 1656)

  • This measure would permit employers to make up to $5,250 per year in tax-free student loan repayments on behalf of employees, and provide an employer tax credit based on 50% of contributions made within that dollar limit.
  • It would also permit employers to make up to $5,250 per year in the form of “qualified dependent 529 contributions” direct to employees’ tax-exempt tuition savings accounts set up on behalf of their children (up to age 19; students up to age 24), and would provide a corresponding 50% employer tax credit.
  • If passed it would thereby double the current $5,250 limit on employer education assistance under Internal Revenue Code (“Code) § 127.
  • Significant for smaller employers, the HELP for Students and Parents Act would treat sole proprietors and partners as employees for purposes of the excludible contributions.

The Student Loan Repayment Act (H.R. 615)

  • This bill would offer employers a 3-year business tax credit equal to 50% of startup costs for a student loan program (up to $500 per participating employee) under which the employer matches employees’ student loan repayments, up to $2,000 per year.
  • The startup costs are program creation costs, not amounts used for employer matching contributions.
  • The bill would also allow employers who hire “qualified student loan repayers” to claim the Work Opportunity Tax Credit, which encourages hiring of select populations such as veterans and recipients of certain types of public assistance. A “qualified student loan repayer” must have at least an associate’s degree, and outstanding education loans of at least $10,000.

The Student Loan Repayment Assistance Act (H.R. 108)

  • This bill would amend the Code to allow businesses a tax credit for employer-paid student loan repayments made direct to the lender, equal to 10% of the amounts that the employer pays on behalf of any employee, not to exceed $500 per employee per month.
  • The credit would be refundable for small businesses and non-profits who cannot use the credit against taxes.
  • The bill would require a written plan document, notice to employees, annual reporting to IRS and must be made “widely available” to employees (not discriminate in favor of “highly compensated employees”).

The Retirement Improvement and Savings Enhancement (RISE) Act of 2016

  • This measure took the form of a discussion draft in the 2014-2016 Congress but likely will be re-introduced in the current 115th Congress.
  • It would permit employers to make matching contributions to an employee’s 401(k) or SIMPLE IRA account based on his or her student loan repayments, essentially treating employee student loan repayment as equivalent of a 401(k) salary deferral.
  • Its retirement provisions would also curtail currently permissible IRA strategies including “mega Roth IRAs” and stretch IRAs, and would permit IRA contributions after reaching age 70 1/2.

As legislative efforts progress, vendors are already stepping in to the breach. Tuition.io provides a software interface that permits employer money to go direct to repay student loans, without going through employee pay.  The average employer contribution per paycheck is $50 – $200.   Other vendors include Student Loan Genius, PeopleJoy, Peanut Butter, and Gradifi.

One compliance question that these programs raise is whether student loan repayment programs would comprise ERISA plans, subject to trust and reporting requirements, or simply be viewed as “payroll practices” exempt from Title I of ERISA.  They do not provide retirement income or defer compensation to retirement age, thus would not likely be an ERISA pension plan, and do not provide benefits within the definition of ERISA “health and welfare” plans, so probably would not fall within ERISA’s scope.  This should help encourage formation of these programs by employers, as ERISA compliance burdens can be complicated and costly. Employers may still need to meet certain requirements in order to ensure tax-qualified status, however, as in the case of the Student Loan Repayment Assistance Act, which imposes documentation, notice and reporting duties.

Employers that want to address their employees’ student loan debt through workplace financial assistance can take the following steps to help select the program or policy that best suits their needs:

  • Talk to your recruiters and use other methods to estimate the student loan burden faced by your staff and new hire candidates.
  • Carefully evaluate various student loan aid vendors and identify those with the best fit for your organization.
  • Invest time in plan design and scheduling a roll out.
  • Remember that communication and ease of use are both key success factors.
  • Continue to monitor legislation for new assistance options.

State Auto-IRA Programs: What Employers Need to Know

California and four other states (Connecticut, Illinois, Maryland and Oregon) have passed legislation requiring employers that do not sponsor employee retirement plans to automatically withhold funds from employees’ pay, and forward them to IRAs maintained under state-run investment programs. Provided that these auto-IRA programs meet safe harbor requirements recently defined by the Department of Labor in final regulations, the programs will be exempt from ERISA and employers cannot be held liable for investment selection or outcome.  The DOL has also finalized regulations that would permit large cities and other political subdivisions to sponsor such programs where no statewide mandate exists; New York City has proposed its own such program, tentatively dubbed the New York City Nest Egg Plan.

In light of this growing trend, what do employers need to know about auto-IRA programs?   Some key points are listed below:

  1. Some Lead Time Exists. Even for state auto-IRA programs that become effective January 1, 2017 (e.g., in California and Oregon), actual implementation of employee contributions is pushed out to July 1, 2017 (in Oregon) and, in California, enrollment must wait until regulations governing the program are adopted. The California program, titled the California Secure Choice Retirement Savings Program, also phases in participation based on employer size. Employers with 100 or more employees must participate within 12 months after the program opens for enrollment, those with 50 or more within 24 months, and employers with fewer than 50 employees must participate within 36 months. These deadlines may be extended, but at present the earliest round of enrollment is anticipated to occur in 2019.
  2. Employer Involvement is Strictly Limited. The DOL safe harbor prohibits employer contributions to auto-IRAs and requires that employers fulfill only the following “ministerial” (clerical) tasks:
    • forwarding employee salary deferrals to the program
    • providing notice of the program to the employees and maintaining contribution records
    • providing information to the state as required, and
    • distributing state program information to employees.  Note that in California, the Employment Development Department will develop enrollment materials for employers to distribute, and in addition a state-selected third party administrator will collect and invest contributions, effectively limiting the employer role to forwarding salary deferrals.
  3. Employers Always Have the Option of Maintaining their Own Plan. Generally the state auto-IRA programs established to date exempt employers that maintain or establish any retirement plan (401(k), pension, SEP, or SIMPLE), even plans with no auto-enrollment feature or employer match used to encourage employee salary deferrals. Therefore employers need not be significantly out of pocket (other than for administrative fees) to avoid a state auto-IRA mandate. Employers should bear in mind that an employer-sponsored retirement program, even if only a SEP or SIMPLE IRA, helps to attract and retain valued staff, and should consider establishing their own plan in advance of auto-IRA program effective dates for that reason.
  4. Penalties May Apply. California’s auto-IRA program imposes a financial penalty on employers that fail to participate.   The penalty is equal to $250 per eligible employee if employer failure to comply lasts 90 or more days after receipt of a compliance notice; this increases to $500 per employee if noncompliance extends 180 or more days after notification. The Illinois auto-IRA program imposes a similar penalty.
  5. Voluntary Participation in Auto-IRA Program May Create an ERISA Plan. One of the requirements of the DOL safe harbor is that employer participation in auto-IRA programs (referred to as “State payroll deduction savings programs” be compulsory under state law. If participation is voluntary, an employer will be deemed to have established an ERISA plan. In theory, this rule could be triggered when an employer that was mandated to participate later drops below the number of employees needed to trigger the applicable state mandate (for instance, a California employer that drops below 5 employees), but continues to participate. The DOL leaves it to the states to determine whether participation remains compulsory for employers despite reductions in the number of employees.   The DOL also notes that, under an earlier safe harbor regulation from 1975, an employer that is not subject to state mandated auto-IRA programs can forward employees’ salary deferrals to IRAs on their behalf without triggering ERISA, provided that the employee salary deferrals are voluntary and not automatic.   The DOL final regulations can be read to suggest that a payroll-to-IRA forwarding arrangement that is voluntary and that meets the other requirements of the 1975 safe harbor will constitute a pre-existing workplace savings arrangement for purposes of exempting an employer from a state-mandated auto-IRA program.
  6. The Trump Administration Will Likely Support Auto-IRA Programs. Early and necessarily tentative conclusions are that the Trump Administration will continue to support the DOL’s safe harbor regulation exempting auto-IRA programs from ERISA, as well as other state-based efforts to address the significant savings gap now known to confront much of the country’s workforce.   One unknown variable is the degree to which the Trump Administration will be influenced by opposition to the programs mounted by the financial industry. Until the direction of the Trump Administration becomes clearer, employers that do not currently maintain a retirement plan should track auto-IRA legislation in their state or city and otherwise prepare to comply with a state or more local program in the near future, ideally by adopting their own retirement plan for employees.

A Conversation About the DOL Fiduciary Rule (Audio File)

The Department of Labor recently published a final regulation defining a “fiduciary” for purposes of investment advice rendered for a fee with regard to “retirement accounts.” The final regulation marks the first change in the regulatory definition of this type of fiduciary since the regulation originally was published in 1975. Retirement accounts under the new rule include those held under qualified plans (e.g., 401(k), pension plans), which have always been subject to ERISA, and now for the first time with regard to IRAs, which formerly were subject only to Internal Revenue Code rules governing self-dealing and other forms of prohibited transactions that the Internal Revenue Service enforced through audits.  The new rule – together with new and amended prohibited transaction exemptions related to the rule – becomes applicable on April 10, 2017, with full implementation required on and after January 1, 2018.

Recently I was interviewed about the new definition of an investment advice fiduciary for an episode of Money Talk that KZSB (1290 AM) will broadcast a 2:00 p.m. PDT on June 20, 2016.  The interview provides a broad overview of the rule and how it will likely impact IRA investors, employers, and the investment industry.  Joining me were program hosts Dianne Duva, Partner at Arlington Financial Advisors, and Neil Kriesel, who worked in finance for many years, has taught at SBCC as an adjunct faculty member and serves on the SBCC Foundation Board and various other non-profit organizations.  Click below to listen.

IRS Announces Increased 2015 Retirement Plan Contribution Limits

On October 23, 2014 the IRS announced 2015 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.   A 1.7% rise in the September CPI-U over 2013 triggered $500 increases to the annual maximum salary deferral limit for 401(k) plans, and the catch-up limit for individuals age 50 or older. Citations below are to the Internal Revenue Code.

Limits That Increase for 2015 Are As Follows:

–The annual Salary Deferral Limit for 401(k), 403(b), and most 457 plans, currently $17,500, increases $500 to $18,000.

–The age 50 and up catch-up limit also increases $500, to $6,000 total. This means that the maximum plan deferral an individual age 50 or older in 2015 may make is $24,000.

–Maximum total annual contributions to a 401(k) or other “defined contribution” plans under 415(c) increased from $52,000 to $53,000 ($59,000 for employees aged 50 and older).

–Maximum amount of compensation on which contributions may be based under 401(a)(17) increased from $260,000 to $265,000.

–The compensation threshold for determining a “highly compensated employee” increased from $115,000 to $120,000.

–The compensation threshold for SEP participation increased from $550 to $600.

–The SIMPLE 401(k) and IRA contribution limit increased $500 to $12,500.

–The Social Security Taxable Wage Base for 2015 increased from $117,000 to $118,500.

Limits That Stayed The Same for 2015 Are As Follows:

–Traditional and Roth IRA contributions and catch-up amounts remain unchanged at $5,500 and $1,000, respectively.

–The compensation dollar limit used to determine key employees in a top-heavy plan remains unchanged at $170,000.

–The maximum annual benefit under a defined benefit plan remained at $210,000.

 

IRS Announces 2014 Benefit Limits

On October 31, 2013 the IRS announced 2014 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.  The announcement had been delayed until the September 2013 Consumer Price Index for Urban Consumers (CPI-U) was available, which in turn was delayed by the government shutdown over the budget and debt ceiling debate.   A modest 1.2% rise in the September CPI-U over 2013 left a number of the dollar limits unchanged for 2014, although a few limits have increased (citations are to the Internal Revenue Code).
Some limits that did not change for 2014 are as follows:
–Salary Deferral Limit for 401(k), 403(b), and 457 plans remains unchanged at $17,500. The age 50 and up catch-up limit also remains unchanged at $5,500 for a total contribution limit of $23,000.
–The compensation threshold for “highly compensated employee” remained at $115,000 for a second year in a row.
–Traditional and Roth IRA contributions and catch-up amounts remain unchanged at $5,500 and $1,000, respectively.
–SIMPLE 401(k) and IRA contribution limits remain at $12,000.
Limits that did increase are as follows:
–Maximum total contribution to a 401(k) or other “defined contribution” plans under 415(c) increased from $51,000 to $52,000 ($57,500 for employees aged 50 and older).
–Maximum amount of compensation on which contributions may be based under 401(1)(17) increased from $255,000 to $260,000.
–Maximum annual benefit under a defined benefit plan increased from $205,000 to $210,000.
–Social Security Taxable Wage Base increased from $113,700 to $117,000.
–The dollar limit defining “key employee” in a top-heavy plan increased from $165,000 to $170,000.

Roundup of DOMA Guidance re: Benefit Plans

The Internal Revenue Service and Department of Labor have in recent months issued initial guidance to employers on the benefit plan consequences of the U.S. Supreme Court’s June 2013 decision in U.S. v. Windsor, 133 S.Ct. 2675 (2013), which ruled Section 3 of the federal Defense of Marriage Act (“DOMA”) to be unconstitutional on equal protection grounds.  That now defunct DOMA provision limited the federal law definitions of “marriage” and “spouse” to refer only to unions between members of the opposite sex.

The recent guidance, which I summarize below (and have separately addressed in earlier posts), represents early stages in the process of fully implementing the US v. Windsor holding within ERISA’s extensive compliance regime.  Please note that this post focuses on the federal tax consequences of same-sex benefits; state taxation of such benefits, and those provided to domestic partners, depends upon the revenue and taxation laws of each state.

IRS and DOL Adopt “State of Celebration” Rule

In U.S. v. Windsor the Supreme Court held that federal law will recognize all “lawful marriages” between members of the same sex, but left open the question of which state’s law will determine whether a same-sex marriage is lawful:  the state of domicile (where the married couple lives), or the state of “celebration” (where the marriage took place).

This is an important question because the Supreme Court decision left intact Section 2 of DOMA, under which a state, territory or Indian tribe need not give effect to another state’s laws regarding same-sex marriage.  The “state of domicile” rule, if it determined whether or not a same-sex couple was legally married, could cause benefits chaos.  For instance, an employer with operations in multiple states would be required to track where each employee in a same-sex relationship lived, and possibly modify their benefit offerings if they moved from a state that recognizes same-sex marriage, to a “non-recognition” state.

Note:  As of the date of this post, the District of Columbia and 14 states recognize same-sex marriage: California (since June 28, 2013, also prior to November 5, 2008); Connecticut; Delaware (eff. 7/1/2013); Iowa; Maine; Maryland; Massachusetts; Minnesota (eff. Aug. 1, 2013); New Hampshire; New Jersey (eff. October 21, 2013); New York; Rhode Island (eff. Aug. 1, 2013); Vermont; and Washington.  (Follow updates to this list here.)

The U.S. v. Windsor ruling also gave rise to some confusion over the status, under federal law, of domestic partnerships, civil unions, and other formalized same-sex relationships that fall short of marriage.

Fortunately, both the IRS and the DOL have resolved these issues in separate guidance released in September 2013.

Specifically, in Revenue Ruling 2013-17, the IRS announced that:

  • The IRS will recognize, as a legal marriage for all federal tax purposes, a marriage of same-sex individuals that was validly entered into in a domestic or foreign jurisdiction that recognizes same sex marriage, regardless of where the couple lives.
  • Under federal tax law, the terms “husband,” “wife,” “husband and wife,” “marriage” and “spouse” includes lawful same-sex marriages and individuals in such marriages.
  • “Marriage” for federal tax purposes does NOT include domestic partnerships, civil unions, or other formal relationships falling short of marriage.

To reach these conclusions the IRS invoked a prior Revenue Ruling from 1958 (Rev. Rul. 58-66) that held that individuals who became common-law spouses under state law were entitled to be treated as legally married spouses for federal income tax purposes regardless of where they later resided.

The DOL also adopted the “state of celebration” rule for purposes of defining same-sex marriage under ERISA benefit plans, including retirement plans, in Technical Release 2013-14.  In this guidance, published September 18, 2013, the DOL also specifies that the terms “spouse” and “marriage,” for ERISA purposes, do not include domestic partnerships or civil unions, whether between members of the same sex or opposite sex, regardless of the standing such relationships have under state law.

The IRS ruling takes effect September 16, 2013 on a prospective basis.  The DOL Technical Release should be treated as effective immediately on a prospective basis.  The DOL will issue further guidance explaining any retroactive application of the U.S. v. Windsor ruling under ERISA, for instance with regard to previously executed beneficiary designations, plan distribution elections, plan loans and hardship distributions.

Other Tax Guidance from Revenue Ruling 2013-17 and FAQs

Revenue Ruling 2013-17 also contains guidance on prospective and retroactive tax filing aissues resulting from the U.S. v. Windsor decision, including refund/credit opportunities.  More specific guidance for taxpayers is set forth in separate IRS FAQs for same-sex married couples, and for couples in registered domestic partnerships.

In order to understand  the tax refund/credit procedures it is helpful first to review the federal tax consequences of providing employment benefits to same-sex spouses while Section 3 of DOMA remained in effect.

Through Internal Revenue Code (“Code”) Section 105(b), Federal law has long allowed employers to provide health and other benefits on a tax-free basis to employees, their opposite-sex spouses and dependents.  However, under DOMA § 3, the same benefits provided to same-sex spouses and other partners generally resulted in “imputed incometo the employee for federal tax purposes, in an amount generally equal to the value of the benefits provided.  Similarly, employees could not use Sec. 125 cafeteria plans to pay premiums for same-sex spouses/partners on a pre-tax basis.  Only in rare instances where the same-sex spouse was a dependent of the employee spouse as a result of disability, did same-sex spousal coverage not result in an additional federal tax burden to the employee spouse.

Note that benefits provided to domestic partners and partner in civil unions are still treated this way for Federal tax purposes.  For benefits provided to employees who are lawfully married to same-sex spouses, however, the new rules effective September 16, 2013 and prospectively are as follows:

  • Individuals in lawful same-sex marriages must file their federal income tax returns for 2013 and subsequent years as either married filing jointly, or married filing separately.
  • Employer-provided benefits provided to an employee’s lawfully-married same-sex spouse are excludable from the employee’s income for federal tax purposes.
  • As a consequence, employers must stop imputing income to employees, for federal tax purposes, based on same-sex spousal benefits, and must adjust affected employees’ Form W-2 income for 2013 to remove imputed income amounts.
  • The tax-qualified benefit plans that are affected are:
    • health, dental and vision coverage;
    • qualified tuition reduction plans maintained by educational organizations;
    • meals and lodging provided to employees on business premises (other specific conditions apply);
    • fringe benefit including qualified transportation fringe benefits, moving expenses, employee discounts, and work-related expenses; and
    • pre-tax participation in Section 125 cafeteria/flex plans, including health flexible spending accounts and dependent care flexible spending accounts.
  • Employees in lawful same-sex marriages can file amended personal income tax returns for “open” tax years (generally 2010, 2011, 2012) to recoup over-withheld federal income taxes resulting from imputed income and after-tax cafeteria plan participation.
  • However, if they re-file, they must re-file as married for all tax purposes, not just to obtain the refund or credit.  In many cases, the income tax adjustment will not warrant the loss of other deductions.  Employees must consult their individual CPAs and other tax advisors for answers; employers must refrain from offering any specific advice or guidance in this regard.

Corrective Payroll/Withholding Steps for 2013 and Prior “Open” Tax Years

IRS Notice 2013-61, published September 23, 2013, sets forth optional, streamlined ways for employers to claim refunds of over-withheld “employment taxes” (FICA and federal income taxes) applied to imputed income/same sex spouse benefits in 2013, and prior “open” tax years.

The “normal” over-withholding correction process – which remains available to employers in this instance – varies slightly depending on whether or not the employer is seeking an adjustment of withholding taxes, or a refund of withholding taxes, but generally includes the following steps:

  • identify the amount of over-withholding;
  • repay the employee’s portion to the employee in cash (or “reimburse” them by applying the overpayment to FICA taxes for current year);
  • obtain written statements from affected employees that they will not also claim a refund of over-withheld FICA taxes, and if an employer is seeking a refund of over-withheld taxes, obtain affected employees’ written consent to the refund; and
  • file IRS Form 941-X for each quarter affected, to recoup the employer portion of the tax.

Notice 2013-61 sets forth two streamlined correction methods permitting use of one single Form 941 or Form 941-X for all of 2013.  Under the first method, the employer takes the following steps before the end of the current year:

  • identify and repay/reimburse employees’ share of excess income tax, FICA tax withholdings resulting from same-sex spousal benefits on or before December 31, 2013; and
  • make corresponding reductions in affected employees’ wage and income-tax withholding amounts on the 4th quarter 2013 Form 941.

The second method is available if the employer does not identify and repay/reimburse employees’ share of excess income tax, FICA tax withholdings until after December 31, 2013.  In that case the employer:

  • Files one single Form 941-X in 2014 seeking reimbursement of employer’s share of tax with regard to imputed income for same-sex spouse benefits reported in all quarters of 2013.
  • In addition to the regular Form 941-X filing requirements, including obtaining written statements and/or consents from employees, employers must write “WINDSOR” at the top of the Form 941-X and must file amended Form W-2s (IRS Form W-2c) for affected employees, reporting the reduced amount of wages subject to FICA withholding.

Note:  This second correction method can apply only to FICA taxes.  Employers cannot make adjustments for overpayments of income tax withholding for a prior tax year unless an administrative error (e.g., wrong entry on Form 941) has occurred.

Employers may also recoup their share of FICA taxes for earlier open tax years (generally, 2010, 2011 and 2012) using one Form 941-X for all four calendar quarters that is filed for the fourth quarter of each affected year.  In addition to marking the Form “WINDSOR” the employer must also file amended Form W-2s for affected employees, reporting the reduced amount of wages subject to FICA withholding.

Employers making use of the correction methods set forth in IRS Notice 2013-61 for 2013 or earlier open years must take account of the Social Security Wage Base in effect for applicable years.  For employees whose 2013 compensation exceeds the taxable wage base ($113,700) even after imputed income is eliminated, no corrections for the Social Security component of FICA taxes can be made.  If retroactive corrections are made, you must observe the SS wage base limitations in effect in prior years:  $106,800 for 2010 & 2011, and $110,100 for 2012.

One final note:  many employers that provide benefits to employees’ domestic partners and/or same sex spouses have followed a practice of grossing up the employees’ taxable compensation to account for the additional federal taxes they must pay on imputed income.  The IRS guidance on recouping over-withheld taxes apply only to imputed income amounts, not to the gross-up amounts.  “Normal” over-withholding correction procedures using Forms 941 and 941-X should apply to 2013 gross-up amounts but employers should consult their payroll and tax advisors for specific advice.  Note also that California recently adopted a law that will exclude gross-up amounts from employees’ taxable compensation for state personal income tax purposes.  AB 362 takes immediate effect and is slated to expire January 1, 2019.  You can find a fuller discussion of the measure here.